Wednesday, August 03, 2011

Spain's High Risk Election Process

As Mr Zapatero put it on Saturday, when he announced the date of Spain's general election, the decision "is in the country's interest" since from now on there will be certainty, and "certainty is stability". While it is quite possible that almost all of Spain's politicians shared this sentiment, and welcomed the bringing forward of the election date, they may very well be the only ones to do so. Certainty is undoubtedly a strong positive, but when the only thing about your country which people can be certain of is the election date, then maybe on balance you won't have gained much.

In fact, as we are now seeing, you may well have lost a lot, and thus many of those who assented to the announcement with a knowing nod of the head may already be rueing the careless moment when they did so, as the country's debt crisis escalates, and the sovereign spread with Germany hits ever higher levels. Could they not comprehend that, seen from the outside, the very fact that the coming of these elections could be seen as good news inside Spain simply constituted one further illustration of just how parochial the country's politicians are, and how detached from economic realitities of their country they have become? They have simply turned themselves into the victims of their own propaganda, since if they hadn't been watching too much Spanish television they would have realised the the country's economy was on the verge of a double dip contraction, and not the imminent recovery which was used as justification for the election call.

Had they read their own official and Eurostat reports they would have known that unemployment was rising not falling - it hit 21% in June according to Eurostat data, and went up by a seasonally adjusted 29,603 between June and July, according to the monthly report from the Spanish labour office.

And had they been following events on the ground rather than election timetables they would have been aware that the housing market,far from having bottomed out had just entered another downward slump. The interannual rate of price decline according to the TINSA valuers index has risen steadily from 3.71% in March, to 4.38% in April, to 5.88% in May, to 6.6% in June. Back in October last year Mr Zapatero famously informed a stupified Maria Bartiromo from CNBC that Spanish house prices had bottomed:

MS. BARTIROMO: Are you expecting real-estate prices to continue coming down? Have they hit the bottom or not yet?

PRIME MIN. ZAPATERO: I think that the price of housing has hit the bottom. It won’t go down any more. For the past two or three months, what we see is that not only has it not dropped. But in certain parts of Spain, the price of housing has gone up. This is especially the case in those areas of — not where people are buying their second house, if you like, with the prices there have still gone down a bit, but rather where they’re buying their first, there the prices have gone down in the housing sector. So in general the prices have been stable recently, and they’ve even been increasing. So demand seems to be ticking up again.

Even more importantly, the recent rise in the 10 year bond yield (and spread) had been giving clear signals that the whole "decoupling" thesis behind whose figleaf the Spanish administration had been guarding their chastity had now become bereft of all credibility.

So the only (and I do mean only) positive Spain had to cling onto before the markets was the credibility it could have earned by coming in with a 6% deficit result on target this December.

If Spain needed a change of government (and I fully accept it did), then what it needed was some kind of "save the nation" (and the euro) coalition, to thrash out what would effectively be a new set of Pactos de la Moncloa, such is the gravity of the situation facing the country, and indirectly the European Union. (The Pactos de la Moncloa were the agreements reached between the various parties to facilitate a bloodless transition from dictatorship to democracy in the initial post-Franco years). But times have changed, and far from being able to achieve major aggreements of state, Spain's political parties are typically too heavily committed to endulging themselves in squabbling over the post boom-years leftovers to busy themselves with more pressing concerns like finding collective solutions to their country's (and Europe's) problems.

Outside Spain things are seen in a rather different eye. Victor Mallet, writing in the Financial Times, put it like this: "neither the certainty of an election date nor the probable victory of the rightwing opposition Popular party will necessarily soothe investors’ fears about where Spain is headed", he said, just before citing Nicholas Spiro of Spiro Sovereign Strategy to the effect that “Spain’s debt market needs this election like it needs a hole in the head". Well, some of the country's leaders might be forgiven for feeling, in the light of what has now transpired, that it is they and not the markets who have been left with a hole in the head, or at least a large gaping hole in the side of their already leaky ship.

Mr Zapatero's actual choice of words was at one and the same time interesting, and revealing. “On January 1, the new government must work on economic recovery and on reducing the deficit.” Excellent, the thread will be picked up again at the start of 2012. And in the meantime? The real issue facing investors and financial market participants at this moment is what is going to happen to the deficit between now and the 31st December. By no stretch of the imagination can Spanish pre-election periods be considered to be propitious for spending cuts.

Concerns about regional spending were already widespread before the election announcement. Commerzbanks Ralph Solveen in a report expressing widely shared views and revealing the sense of frustration already felt by many analysts and observers, desribed the possibilty of Spain achieving the 6% target by the end of this year as increasingly remote. And his reasoning was impeccable:

The Spanish central government is still only managing to reduce its budget deficit at a very slow pace. According to figures published today, its deficit for the first half of the year was just €5.6 billion lower than in the same period last year. In addition, most of the Spanish regions reported higher deficits than last year, so this year's target for reducing the overall government deficit ratio from 9.2 per cent to 6 per cent, is now receding into the distance.......This figure is only slightly higher than the reduction of €4.5 billion that was reported at the end of May, such that the reduction per month fell.

Consequently, the target set for reducing the overall government deficit by more than three percentage points this year is becoming even more remote, all the more so because the first quarter deficits reported for the regions were, on average, even higher than last year. The figures for the second quarter are not yet available, but reports for individual regions such as Castile-La Mancha bring little hope of a significant change for the better.

Part of the reason for the slow rate of deficit reduction has been the fact that economic growth is slower than forecast, a problem which is hitting revenues. Naturally a further batch of measures really are needed, but what sort of "swingeing cuts" can we realistically expect to see from a government which is in the midst of a battle for its political life? Telling government employees that they will lose half of their 2 extra monthly payments (one policy option strongly rumoured to have been under consideration before the election announcement) would hardly be likely to win them votes.

As I say, the tragedy in all this is that achieving the deficit target was about the one (and only) thing the government had going for it. The only real proof of its seriousness. Despite all the scepticism about (and slippage in) regional finance, I would have been prepared to sign on to the idea that Spain's deficit would still come in around the 6% mark. But now,.......

The deficit progress was what Spain had to put on the table, since when you come to all the rest, economic growth, employment and unemployment, financial sector reform, the housing market the only thing the sky was really full of were black clouds.

Naturally, the election declaration was only what the Greek historian Thucydides would have called the efficient cause (or trigger) for the next stage in the crisis, the final cause is the inability of either Madrid, or Brussels, or Washington (the IMF) to come up with an adequate policy mix to drag the Spanish economy out of the hole into which it has fallen, and into which (short of viable remedies) it will soon drag the Spanish and then the European financial systems along behind it.

Going naked (not a fig leaf is left) into the conference chamber sounds like a very apt and appropriate desciption of where Mr Zapatero and his team are right now. The situation can hardly be comfortable for them, but then, at the end of the day sympathy would be misplaced, since the only people responsible (or should that be "irresponsible") for the decision and hence the situation are they themselves and those who lead the governing PSOE party. Unfortunately though they will not be the only ones who pay the consequences.